Article I, Section 10, Clause 1:
No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.
The Contract Clause provides that no state may pass a
Law impairing the Obligation of Contracts, and a
law in this context may be a statute, constitutional provision, 1 municipal ordinance, 2 or administrative regulation having the force and operation of a statute. 3 But are judicial decisions within the clause? The abstract principle of the separation of powers, at least until recently, forbade the idea that the courts
make law and the word
pass in the above clause seemed to confine it to the formal and acknowledged methods of exercise of the law-making function. Accordingly, the Court has frequently said that the clause does not cover judicial decisions, however erroneous, or whatever their effect on existing contract rights. 4 Nevertheless, there are important exceptions to this rule that are set forth below.
Status of Judicial Decisions
Although the highest state court usually has final authority in determining the construction as well as the validity of contracts entered into under the laws of the state, and federal courts will be bound by decisions of the highest state court on such matters, this rule does not hold when the contract is one whose obligation is alleged to have been impaired by state law. 5 Otherwise, the challenged state authority could be vindicated through the simple device of a modification or outright nullification by the state court of the contract rights in issue. Similarly, the highest state court usually has final authority in construing state statutes and determining their validity in relation to the state constitution. But this rule too has had to bend to some extent to the Supreme Court's interpretation of the Contract Clause. 6
Suppose the following situation: (1) a municipality, acting under authority conferred by a state statute, has issued bonds in aid of a railway company; (2) the validity of this statute has been sustained by the highest state court; (3) later the state legislature repeals certain taxes to be used to pay off the bonds when they become due; (4) the repeal is sustained by a decision of the highest state court holding that the statute authorizing the bonds was unconstitutional ab initio. In such a case the Supreme Court would take an appeal from the state court and would reverse the latter's decision of unconstitutionality because of its effect in rendering operative the repeal of the tax. 7
Suppose, however, that the state court has held the statute authorizing the bonds unconstitutional ab initio in a suit by a creditor for payment without the state legislature's having repealed the taxes. In this situation, the Supreme Court would still afford relief if the case were one between citizens of different states, which reached it via a lower federal court. 8 This is because in cases of this nature the Court formerly felt free to determine questions of fundamental justice for itself. Indeed, in such a case, the Court in the past has apparently regarded itself as free to pass upon the constitutionality of the state law authorizing the bonds even though there had been no prior decision by the highest state court sustaining them, the idea being that contracts entered into simply on the faith of the presumed constitutionality of a state statute are entitled to this protection. 9
In other words, in cases in which it has jurisdiction because of diversity of citizenship, the Court has held that the obligation of contracts is capable of impairment by subsequent judicial decisions no less than by subsequent statutes, and that it is able to prevent such impairment. In cases, on the other hand, of which it obtains jurisdiction only on the constitutional ground and by appeal from a state court, it has always adhered in terms to the doctrine that the word
laws as used in Article I, § 10, does not include judicial decisions. Yet, even in these cases, it will intervene to protect contracts entered into on the faith of existing decisions from an impairment that is the direct result of a reversal of such decisions, but there must be in the offing, as it were, a statute of some kind – one possibly many years older than the contract rights involved – on which to pin its decision. 10
In 1922, Congress, through an amendment to the Judicial Code, endeavored to extend the reviewing power of the Supreme Court to
any suit involving the validity of a contract wherein it is claimed that a change in the rule of law or construction of statutes by the highest court of a State applicable to such contract would be repugnant to the Constitution of the United States . . . . 11 This appeared to be an invitation to the Court to say frankly that the obligation of a contract can be impaired by a subsequent court decision. The Court, however, declined the invitation in an opinion by Chief Justice Taft that reviewed many of the cases covered in the preceding paragraphs.
Dealing with Gelpcke and subsequent decisions, Chief Justice Taft said:
These cases were not writs of error to the Supreme Court of a State. They were appeals or writs of error to federal courts where recovery was sought upon municipal or county bonds or some other form of contracts, the validity of which had been sustained by decisions of the Supreme Court of a State prior to their execution, and had been denied by the same court after their issue or making. In such cases the federal courts exercising jurisdiction between citizens of different States held themselves free to decide what the state law was, and to enforce it as laid down by the State Supreme Court before the contracts were made rather than in later decisions. They did not base this conclusion on Article I, § 10, of the Federal Constitution, but on the state law as they determined it, which, in diverse citizenship cases, under the third Article of the Federal Constitution they were empowered to do. Burgess v. Seligman,  12 Although doubtless this was an available explanation in 1924, the decision in 1938, in Erie Railroad Co. v. Tompkins, 13 so cut down the power of the federal courts to decide diversity of citizenship cases according to their own notions of
general principles of common law as to raise the question whether the Court will not be required eventually to put Gelpcke and its companions and descendants squarely on the Contract Clause or else abandon them.
A contract is analyzable into two elements: the agreement, which comes from the parties, and the obligation, which comes from the law and makes the agreement binding on the parties. The concept of obligation is an importation from the civil law and its appearance in the Contract Clause is supposed to have been due to James Wilson, a graduate of Scottish universities and a civilian. Actually, the term as used in the Contract Clause has been rendered more or less superfluous by the doctrine that
[t]he laws which exist at the time and place of the making of a contract, and where it is to be performed, enter into and form a part of it. 14 Hence, the Court sometimes recognizes the term in its decisions applying the clause, and sometimes ignores it. In Sturges v. Crowninshield, 15 Chief Justice Marshall defined
obligation of contract as the law that binds a party
to perform his undertaking, but a little later the same year, in Dartmouth College v. Woodward, he set forth the points presented for consideration to be:
1. Is this contract protected by the constitution of the United States? 2. Is it impaired by the acts under which the defendant holds? 16 The word
obligation undoubtedly implies that the Constitution was intended to protect only executory contracts – i.e., contracts still awaiting performance – but this implication was rejected early on for a certain class of contracts, with immensely important result for the clause.
The obligations of a contract, said Chief Justice Hughes for the Court in Home Building & Loan Ass'n v. Blaisdell, 17
are impaired by a law which renders them invalid, or releases or extinguishes them . . . , and impairment . . . has been predicated upon laws which without destroying contracts derogate from substantial contractual rights. 18 But he adds:
Not only are existing laws read into contracts in order to fix obligations as between the parties, but the reservation of essential attributes of sovereign power is also read into contracts as a postulate of the legal order. The policy of protecting contracts against impairment presupposes the maintenance of a government by virtue of which contractual relations are worthwhile, – a government which retains adequate authority to secure the peace and good order of society. This principle of harmonizing the constitutional prohibition with the necessary residuum of state power has had progressive recognition in the decisions of this Court. 19 In short, the law from which the obligation stems must be understood to include constitutional law and, moreover a
progressive constitutional law. 20
private contract is, naturally, not all-inclusive. A judgment, though granted in favor of a creditor, is not a contract in the sense of the Constitution, 21 nor is marriage. 22 And whether a particular agreement is a valid contract is a question for the courts, and finally for the Supreme Court, when the protection of the contract clause is invoked. 23
The question of the nature and source of the obligation of a contract, which went by default in Fletcher v. Peck and the Dartmouth College case, with such vastly important consequences, had eventually to be met and answered by the Court in connection with private contracts. The first case involving such a contract to reach the Supreme Court was Sturges v. Crowninshield, 24 in which a debtor sought escape behind a state insolvency act of later date than his note. The act was held inoperative, but whether this was because of its retroactivity in this particular case or for the broader reason that it assumed to excuse debtors from their promises was not at the time made clear. As noted earlier, Chief Justice Marshall's definition on this occasion of the obligation of a contract as the law that binds the parties to perform their undertakings was not free from ambiguity, owing to the uncertain connotation of the term
These obscurities were finally cleared up for most cases in Ogden v. Saunders, 26 in which the temporal relation of the statute and the contract involved was exactly reversed – the former antedating the latter. Chief Justice Marshall contended unsuccessfully that the statute was void because it purported to release the debtor from that original, intrinsic obligation that always attaches under natural law to the acts of free agents.
When, he wrote,
we advert to the course of reading generally pursued by American statesmen in early life, we must suppose that the framers of our Constitution were intimately acquainted with the writings of those wise and learned men whose treatises on the laws of nature and nations have guided public opinion on the subjects of obligation and contracts, and that they took their views on these subjects from those sources. He also posed the question of what would happen to the Contract Clause if states might pass acts declaring that all contracts made subsequently thereto should be subject to legislative control. 27
For the first and only time, a majority of the Court abandoned the Chief Justice's leadership. Speaking by Justice Washington, it held that the obligation of private contracts is derived from the municipal law – state statutes and judicial decisions – and that the inhibition of Article I, § 10, is confined to legislative acts made after the contracts affected by them, subject to the following exception. By a curiously complicated line of reasoning, the Court also held in the same case that, when the creditor is a nonresident, then a state by an insolvency law may not alter the former's rights under a contract, albeit one of later date.
With the proposition established that the obligation of a private contract comes from the municipal law in existence when the contract is made, a further question presents itself, namely, what part of the municipal law is referred to? No doubt, the law which determines the validity of the contract itself is a part of such law. Also part of such law is the law which interprets the terms used in the contract, or which supplies certain terms when others are used, as for instance, constitutional provisions or statutes which determine what is
legal tender for the payment of debts, or judicial decisions which construe the term
for value received as used in a promissory note, and so on. In short, any law which at the time of the making of a contract goes to measure the rights and duties of the parties to it in relation to each other enters into its obligation.
Remedy a Part of the Private Obligation
Suppose, however, that one of the parties to a contract fails to live up to his obligation as thus determined. The contract itself may now be regarded as at an end, but the injured party, nevertheless, has a new set of rights in its stead, those which are furnished him by the remedial law, including the law of procedure. In the case of a mortgage, he may foreclose; in the case of a promissory note, he may sue; and in certain cases, he may demand specific performance. Hence the further question arises, whether this remedial law is to be considered a part of the law supplying the obligation of contracts. Originally, the predominating opinion was negative, since as we have just seen, this law does not really come into operation until the contract has been broken. Yet it is obvious that the sanction which this law lends to contracts is extremely important – indeed, indispensable. In due course it became the accepted doctrine that part of the law which supplies one party to a contract with a remedy if the other party does not live up to his agreement, as authoritatively interpreted, entered into the
obligation of contracts in the constitutional sense of this term, and so might not be altered to the material weakening of existing contracts. In the Court's own words:
Nothing can be more material to the obligation than the means of enforcement. Without the remedy the contract may, indeed, in the sense of the law, be said not to exist, and its obligation to fall within the class of those moral and social duties which depend for their fulfillment wholly upon the will of the individual. The ideas of validity and remedy are inseparable. . . . 28
This rule was first definitely announced in 1843 in Bronson v. Kinzie. 29 Here, an Illinois mortgage giving the mortgagee an unrestricted power of sale in case of the mortgagor's default was involved, along with a later act of the legislature that required mortgaged premises to be sold for not less than two-thirds of the appraised value and allowed the mortgagor a year after the sale to redeem them. It was held that the statute, in altering the pre-existing remedies to such an extent, violated the constitutional prohibition and hence was void. The year following a like ruling was made in McCracken v. Hayward, 30 as to a statutory provision that personal property should not be sold under execution for less than two-thirds of its appraised value.
But the rule illustrated by these cases does not signify that a state may make no changes in its remedial or procedural law that affect existing contracts.
Provided, the Court has said,
a substantial or efficacious remedy remains or is given, by means of which a party can enforce his rights under the contract, the Legislature may modify or change existing remedies or prescribe new modes of procedure. 31 Thus, states are constantly remodelling their judicial systems and modes of practice unembarrassed by the Contract Clause. 32 The right of a state to abolish imprisonment for debt was early asserted. 33 Again, the right of a state to shorten the time for the bringing of actions has been affirmed even as to existing causes of action, but with the proviso added that a reasonable time must be left for the bringing of such actions. 34 On the other hand, a statute which withdrew the judicial power to enforce satisfaction of a certain class of judgments by mandamus was held invalid. 35 In the words of the Court:
Every case must be determined upon its own circumstances; 36 and it later added:
In all such cases the question becomes . . . one of reasonableness, and of that the legislature is primarily the judge. 37
Contracts involving municipal bonds merit special mention. While a city is from one point of view but an emanation from the government's sovereignty and an agent thereof, when it borrows money it is held to be acting in a corporate or private capacity and so to be suable on its contracts. Furthermore, as was held in the leading case of United States ex rel. Von Hoffman v. Quincy, 38
where a State has authorized a municipal corporation to contract and to exercise the power of local taxation to the extent necessary to meet its engagements, the power thus given cannot be withdrawn until the contract is satisfied. In this case the Court issued a mandamus compelling the city officials to levy taxes for the satisfaction of a judgment on its bonds in accordance with the law as it stood when the bonds were issued. 39 Nor may a state by dividing an indebted municipality among others enable it to escape its obligations. The debt follows the territory and the duty of assessing and collecting taxes to satisfy it devolves upon the succeeding corporations and their officers. 40 But where a municipal organization has ceased practically to exist through the vacation of its offices, and the government's function is exercised once more by the state directly, the Court has thus far found itself powerless to frustrate a program of repudiation. 41 However, there is no reason why the state should enact the role of particeps criminis in an attempt to relieve its municipalities of the obligation to meet their honest debts. Thus, in 1931, during the Great Depression, New Jersey created a Municipal Finance Commission with power to assume control over its insolvent municipalities. To the complaint of certain bondholders that this legislation impaired the contract obligations of their debtors, the Court, speaking by Justice Frankfurter, pointed out that the practical value of an unsecured claim against a city is
the effectiveness of the city's taxing power, which the legislation under review was designed to conserve. 42
Private Contracts and the Police Power
The increasing subjection of public grants to the police power of the states has been previously pointed out. That purely private contracts should be in any stronger situation in this respect obviously would be anomalous in the extreme. In point of fact, the ability of private parties to curtail governmental authority by the easy device of contracting with one another is, with an exception to be noted, even less than that of the state to tie its own hands by contracting away its own powers. So, when it was contended in an early Pennsylvania case that an act prohibiting the issuance of notes by unincorporated banking associations violated the Contract Clause because of its effect upon certain existing contracts of members of such association, the state Supreme Court answered:
But it is said, that the members had formed a contract between themselves, which would be dissolved by the stoppage of their business. And what then? Is that such a violation of contracts as is prohibited by the Constitution of the United States? Consider to what such a construction would lead. Let us suppose, that in one of the States there is no law against gaming, cock-fighting, horse-racing or public masquerades, and that companies should be formed for the purpose of carrying on these practices. . . . Would the legislature then be powerless to prohibit them? The answer returned, of course, was no. 43
The prevailing doctrine was stated by the U.S. Supreme Court:
It is the settled law of this court that the interdiction of statutes impairing the obligation of contracts does not prevent the State from exercising such powers as are vested in it for the promotion of the common weal, or are necessary for the general good of the public, though contracts previously entered into between individuals may thereby be affected. . . . In other words, that parties by entering into contracts may not estop the legislature from enacting laws intended for the public good. 44
So, in an early case, we find a state recording act upheld as applying to deeds dated before the passage of the act. 45 Later cases have brought the police power in its more customary phases into contact with private as well as with public contracts. Lottery tickets, valid when issued, were necessarily invalidated by legislation prohibiting the lottery business; 46 contracts for the sale of beer, valid when entered into, were similarly nullified by a state prohibition law; 47 and contracts of employment were modified by later laws regarding the liability of employers and workmen's compensation. 48 Likewise, a contract between plaintiff and defendant did not prevent the state from making the latter a concession that rendered the contract worthless; 49 nor did a contract as to rates between two railway companies prevent the state from imposing different rates; 50 nor did a contract between a public utility company and a customer protect the rates agreed upon from being superseded by those fixed by the state. 51 Similarly, a contract for the conveyance of water beyond the limits of a state did not prevent the state from prohibiting such conveyance. 52
But the most striking exertions of the police power touching private contracts, as well as other private interests within recent years, have been evoked by war and economic depression. Thus, in World War I, the State of New York enacted a statute which, declaring that a public emergency existed, forbade the enforcement of covenants for the surrender of the possession of premises on the expiration of leases, and wholly deprived for a period owners of dwellings, including apartment and tenement houses, within the City of New York and contiguous counties, of possessory remedies for the eviction from their premises of tenants in possession when the law took effect, providing the latter were able and willing to pay a reasonable rent. In answer to objections leveled against this legislation on the basis of the Contract Clause, the Court said:
But contracts are made subject to this exercise of the power of the State when otherwise justified, as we have held this to be. 53 In a subsequent case, however, the Court added that, although the declaration by the legislature of a justifying emergency was entitled to great respect, it was not conclusive; a law
depending upon the existence of an emergency or other certain state of facts to uphold it may cease to operate if the emergency ceases or the facts change, and whether they have changed was always open to judicial inquiry. 54
Summing up the result of the cases referred to above, Chief Justice Hughes, speaking for the Court in Home Building & Loan Ass'n v. Blaisdell, 55 remarked in 1934:
It is manifest from this review of our decisions that there has been a growing appreciation of public needs and of the necessity of finding ground for a rational compromise between individual rights and public welfare. The settlement and consequent contraction of the public domain, the pressure of a constantly increasing density of population, the interrelation of the activities of our people and the complexity of our economic interests, have inevitably led to an increased use of the organization of society in order to protect the very bases of individual opportunity. Where, in earlier days, it was thought that only the concerns of individuals or of classes were involved, and that those of the State itself were touched only remotely, it has later been found that the fundamental interests of the State are directly affected; and that the question is no longer merely that of one party to a contract as against another, but of the use of reasonable means to safeguard the economic structure upon which the good of all depends. . . . The principle of this development is . . . that the reservation of the reasonable exercise of the protective power of the States is read into all contracts . . . . 56
Evaluation of the Clause Today
It should not be inferred that the Contract Clause is today totally moribund. Even prior to the most recent decisions, it still furnished the basis for some degree of judicial review as to the substantiality of the factual justification of a professed exercise by a state legislature of its police power, and in the case of legislation affecting the remedial rights of creditors, it still affords a solid and palpable barrier against legislative erosion. Nor is this surprising in view of the fact that, as we have seen, such rights were foremost in the minds of the framers of the clause. The Court's attitude toward insolvency laws, redemption laws, exemption laws, appraisement laws and the like, has always been that they may not be given retroactive operation, 57 and the general lesson of these earlier cases is confirmed by the Court's decisions between 1934 and 1945 in certain cases involving state moratorium statutes. In Home Building & Loan Ass'n v. Blaisdell, 58 the leading case, a closely divided Court sustained the Minnesota Moratorium Act of April 18, 1933, which, reciting the existence of a severe financial and economic depression for several years and the frequent occurrence of mortgage foreclosure sales for inadequate prices, and asserting that these conditions had created an economic emergency calling for the exercise of the State's police power, authorized its courts to extend the period for redemption from foreclosure sales for such additional time as they might deem just and equitable, although in no event beyond May 1, 1935.
The act also left the mortgagor in possession during the period of extension, subject to the requirement that he pay a reasonable rental for the property as fixed by the court. Contemporaneously, however, less carefully drawn statutes from Missouri and Arkansas, acts that were not as considerate of creditor's rights, were set aside as violating the Contract Clause. 59
A State is free to regulate the procedure in its courts even with reference to contracts already made, said Justice Cardozo for the Court,
and moderate extensions of the time for pleading or for trial will ordinarily fall within the power so reserved. A different situation is presented when extensions are so piled up as to make the remedy a shadow. . . . What controls our judgment at such times is the underlying reality rather than the form or label. The changes of remedy now challenged as invalid are to be viewed in combination, with the cumulative significance that each imparts to all. So viewed they are seen to be an oppressive and unnecessary destruction of nearly all the incidents that give attractiveness and value to collateral security. 60 On the other hand, in the most recent of this category of cases, the Court gave its approval to an extension by the State of New York of its moratorium legislation. While recognizing that business conditions had improved, the Court found reason to believe that
the sudden termination of the legislation which has dammed up normal liquidation of these mortgages for more than eight years might well result in an emergency more acute than that which the original legislation was intended to alleviate. 61
In the meantime, the Court had sustained New York State legislation under which a mortgagee of real property was denied a deficiency judgment in a foreclosure suit where the state court found that the value of the property purchased by the mortgagee at the foreclosure sale was equal to the debt secured by the mortgage. 62
Mortgagees, the Court said,
are constitutionally entitled to no more than payment in full. . . . To hold that mortgagees are entitled under the contract clause to retain the advantages of a forced sale would be to dignify into a constitutionally protected property right their chance to get more than the amount of their contracts. . . . The contract clause does not protect such a strategical, procedural advantage. 63
While the Contracts Clause
remains a part of our written Constitution, 64 not every state law affecting preexisting contracts violates the Constitution. 65 Instead, the Court has applied a two-part test to determine whether a law unconstitutionally impairs a contractual obligation. 66 First, the state law must operate as a
substantial impairment of a contractual relationship." 67 To determine whether a substantial impairment has occurred, the Court has considered the extent to which the law undermines the contractual bargain, interferes with a party's reasonable expectations, and prevents the party from safeguarding or reinstating his rights. 68 For instance, in Sveen v. Melin, the Court held that a Minnesota law automatically revoking upon a couple's divorce any life insurance policies designating a spouse to be the beneficiary did
not substantially impair pre-existing contractual arrangements. 69 Specifically, the Sveen Court held as such because the law in question (1) was designed to reflect a policyholder's presumed intent that an ex-spouse not
benefit from [the policyholder's] insurance; 70 (2) does not upset the beneficiary's expectations, as a divorce court's resolution of the marital assets could have upset the beneficiary designation anyways; 71 and (3) provides a mere default rule that could be reversed
with the stroke of the pen. 72 In rejecting the Contracts Clause challenge, the Sveen Court viewed the Minnesota law to be in line with other state laws that imposed default rules facilitating the orderly disposition of property interests. 73
Second, if substantial impairment has occurred, the Court then turns to the
ends of the legislation to determine if it violates the Contracts Clause. 74 Specifically, the Court has asked whether the state law is drawn in an
reasonable way to advance
a significant and legitimate public purpose. 75 Applying this standard, in two cases in the late 1970s, the Court struck down state legislation that impaired either the government's own contractual obligations or private contracts. 76
In United States Trust, the Court ruled that an impairment would be upheld only if it were
reasonable to serve an important public purpose. But the two terms were given restrictive meanings. Necessity is shown only when the state's objectives could not have been achieved through less dramatic modifications of the contract; reasonableness is a function of the extent to which alteration of the contract was prompted by circumstances unforeseen at the time of its formation. The repeal of the covenant in issue was found to fail both prongs of the test. 77
In Spannaus, the Court drew from its prior cases four standards: did the law deal with a broad generalized economic or social problem, did it operate in an area already subject to state regulation at the time the contractual obligations were entered into, did it effect simply a temporary alteration of the contractual relationship, and did the law operate upon a broad class of affected individuals or concerns. The Court found that the challenged law did not possess any of these attributes and thus struck it down. 78
These cases seemed to embody more active judicial review of economic regulatory activities, in contrast to the deference shown such legislation under the due process and equal protection clauses. Both cases contain language emphasizing the breadth of the police powers of government that may be used to further the public interest and admitting limited judicial scrutiny. Nevertheless,
[i]f the Contract Clause is to retain any meaning at all . . . it must be understood to impose some limits upon the power of a State to abridge existing contractual relationships, even in the exercise of its otherwise legitimate police power. 79